Recession (economics)

Recessions have punctuated the growth of the major economies from time to time since the 18th century, causing losses of productive capacity and of human capital. Various remedies have been tried, and it was thought for a time in the late 20th century that a cure had been found. The Great Recession has put an end to that belief and has created a renewed interest in the phenomenon.

Terminology

The terms recession and depression are used colloqually to describe any deep or persistant decline in economic activity, (and sometimes to a persistant reduction in the rate of growth of ouput). More precise definitions have been adopted the statistics authorities. In the United States the National Bureau of Economic Research defines a recession as

a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale retail sales

Other authorities have not adopted a formal definition of recession but most commentators and analysts use

a period of of negative growth of real (inflation-adjusted GDP lasting for at least two quarters]].

The term balance sheet recession has been applied to a reduction in bank lending or consumer spending following the bursting of an asset price bubble. The term double-dip recession refers to a second fall in economic growth following an aborted recovery from a recession, such as occurred in the 1937-39 phase of the Great Depression. The terms downturn, and "trough" are used to denote the onset of negative growth, and the point at which positive growth resumes.

Before 1930, what are now termed recessions were referred to as "depressions". That term is nowadays reserved for exceptionally severe or prolonged recessions. Again there is no formal definition, but it has been suggested that the term be applied to a decline in real GDP that exceeds 10%, or one that lasts more than three years.

How recessions start

Recessions have been triggered by events that have prompted firms and consumers to cut back their spending plans (termed economic shocks). The terms endogenous and exogenous are applied to shocks coming from within and outside the economy, and a distinction is usually drawn between changes of demand and changes of supply. Exogenous demand shocks have included sudden falls in demand for exports, and endogenous demand shocks have included tax increases and credit crunches. Supply shocks, such as commodity price increases, have usually been exogenous. Perceptions of shocks have been influenced by forecasts, rumours and herding behaviour, as well as from factual reports and experiences. Global shocks (such as the crash of 2008) have arisen from the tighly coupled character of modern financial systems, and there have been many instances of the international contagion of domestic shocks.

What happens in a recession

There is an unsettled controversy concerning the mechanism of recessions, but they are known to have a number of common features. The running down of manufacturers' stocks hastens the decline in activity, and their rebuilding hastens its eventual recovery. An output gap develops between the level of output and its former trend, and there is an increase in unemployment. Prices tend to fall in response to the reduction in demand and, if the recession persists, there is a danger of deflation. The economy's automatic stabilisers cause tax revenues to fall and benefit payments to rise, causing an increase in the budget deficit. Depending on the pre-recession level of the foreign-held public debt as a percentage GDP and the prospects of a return to growth, the market may add a risk premium to the yield that it expects from the government's bonds to compensate for the perceived risk of sovereign default. If the market's concern about the government in question develops into one of debt aversion, the premium may rise to a point at which the government finds it difficult to avoid default.

Remedies

Until the 1930s, the prevailing attitude to recessions was passive acceptance - in accordance with the teaching of the Austrian School of economics. Harvard's Joseph Schumpeter argued that "depressions are not simply evils, which we might attempt to suppress, but forms of something which has to be done, namely, adjustment to change.". In the 1930s, limited use was made of public expenditure to counter the Great Depression, and the use of fiscal stimuluses as proposed by John Maynard Keynes gained general acceptance in the 1940s. That remedy was widely abandoned in the 1980s in favour of the use of monetary policy to regulate the output gap by varying short-term interest rates. In the course of the Great Recession of 2007-10 that form of monetary policy was augmented by the use of quantitative easing to expand the money supply, and there was a temporary return to the use of fiscal policy.

The costs of recessions

Recessions impose costs on the community in terms of loss of output, and of reductions in the welbeing of its people.

The value of the reduction in output that occurs in the course of a recession depends pattern of the decline and recovery of output, but the proportion that subsequently remains is determined solely by the nature of recovery . Among the determinants of the speed of recovery, budget deficits have had a positive influence, but, even where the recovery has been rapid, there have been permanent output losses. Long-term costs may also arise from recession-induced losses of physical and humam capital.

Workers that lose their jobs have suffered losses of income, and it has been estimated that they have suffered psychological harm that was as much as three times as important to them. Fear of unemployment is also psychologically harmful, even to the extent of being an important predictor of psychological symptons. The loss of employment by family wage earners has been found to be particularly burdensome because it cuts deeply into their sense of obligation, their identity, and their status; and unemployment after marriage has been found to increase the incidence of divorce. . It has also been found that unemployed men are less healthy and have a higher mortality than employed men .

Recessions in history

The nineteenth century

There are reported to have been eleven recessions of varying severity in the United States between 1865 and 1900 the worst of which was the panic of 1893 in which a monetary crisis led to the failure of 500 banks and an unemployment rate of over ten per cent.

In Britain there were credit-related recessions in 1826 and 1847, and an exceptionally severe downturn in 1858 which was partly a reflection of events in the United States , and a downturn in 1890 triggered by the failure of the Barings bank due to losses affecting its Latin American investments.

The episode that was colloqually known as the "Great Depression of 1873" may not even have been a recession as that term is now defined, but only a protracted reduction in economic growth that continued intermittently until 1895 (although, according to definition used by the United States National Bureau of Economic Research, there were several recessions during that period ). Its distinguishing feature was its length rather than its depth, and also the fact that it had an unprecedentedly internationl impact

The twentieth century

The only major international recession in the inter-war years was the global Great Depression that followed the American stock exchange crash of 1929 the triggering of which has variously been attributed to the bursting of a speculative stock exchange bubble and to a monetary shock administered by the United States Federal Reserve System, leading to persistent deflation. From its origin in the United States, it spread to other industrialised countries, resulting in massive unemployment and human suffering. It lasted in the United States from 1930 until the outbreak of the second world war in 1939.

The most important of the international recessions that occurred in the post-war years of the twentieth century were the global recession of 1973, triggered by the sudden rise in the price of oil, and an Asian recession in the 1990s triggered by the bursting of a real-estate buble and the consequential development of the Asian banking crises.

In addition to the international recessions there were numerous national recessions .

The twenty-first century

The global recession of 2009 is largely attributable to the banking and credit crash of 2008 which was triggered by the bursting of a speculative real-estate bubble in the United States, and the following subprime mortgages crisis.